The Quarterly Statement: Q4 2019
10 Years in 10 Charts: Observations & Implications for the future
As another decade hits the history books, we highlight 10 charts representing notable investment themes of the decade. Where applicable, we assess potential investment implications for the next decade.
- Quantitative Easing Took Center Stage
- Negative Yielding Debt Exploded
- A Recession Free Decade
- U.S. Large Cap Equities Outperformed
- Record Index Concentration
- Growth Trounced Value
- Active vs. Passive Debate Expanded
- ESG Investing Emerged
- China Became a Major Global Economic Player
- Public vs. Private Market Growth Divergence
Quantitative Easing Took Center Stage
Past Decade: After the Great Financial Crisis of 2008, global central banks adopted a non-traditional measure to stimulate the economy. Quantitative Easing (QE), or buying large blocks of government and other securities, was employed to create money supply and dramatically expand central bank balance sheets.
Next Decade: The QE narrative is likely to continue as economies continue to struggle to meet desired growth and inflation levels. Ample liquidity could keep interest rates lower for longer and expected returns muted for traditional income-generating assets such as bonds. For this reason, investors with a return threshold may need to reconsider their traditional 60/40 portfolio construction and turn to riskier alternatives in search of yield.
Negative Yielding Debt Exploded
Past Decade: In addition to QE, central banks introduced negative interest rate policies (NIRP) with the hope that this would stimulate further demand and economic activity. The graph below illustrates the growth of negative yielding debt over the decade.
Next Decade: Unintended consequences of negative interest rates may materialize if central banks begin to reverse course. A directional change in rates higher could contribute to increased volatility and risk of loss in global bond portfolios.
A Recession Free Decade
Past Decade: The end of 2019 marks the first decade without a recession since data collection began in 1900. The number of months in each decade with the U.S. economy in a recession has generally fallen over time, according to data from the National Bureau of Economic Research (NBER).
Next Decade: While a recession will happen at some point, there is no indication that it must occur within a certain time period. Investors may be more fearful of an imminent recession because of a behavioral bias called “due theory” in which individuals assign a higher probability to an event occurring if it has not happened within its normal time frame. Australia has not had a recession in 28 years — making the U.S.’ recession-free decade seem relatively short in comparison.
U.S. Large Cap Equities Outperformed
Past Decade: Helped by the Fed’s accommodative stance throughout the decade and the overall resilience of the U.S. economy following the Great Financial Crisis, U.S. large cap equities, as measured by the S&P 500 Index, were the strongest performing asset class for this decade.
Next Decade: As discussed in our Q3 Quarterly, we believe large cap equity risk premia over the next few years is likely to be lower than what we have experienced over the past decade. We believe that valuations, rising protectionism, and increased investor desire for diversification in search of yield could lead to a stronger tailwind for U.S. small cap equities over the next few years.
Record Index Concentration
Past Decade: The Top 5 constituents of the Russell 1000 Growth and S&P 500 Indices finished the decade with record market cap concentration of almost 30% and 17%, compared to averages over the past 35 years of ~19% and ~13%, respectively . Furthermore, the market cap of the Top 5 constituents of the Russell 1000 Growth Index ended the decade with a value almost $3.7T greater than the market cap of the entire small cap universe (Russell 2000 Index).
Next Decade: Historically, extreme concentration has been followed by underperformance of the top 5 securities relative to their broader indices over the next three years.
Growth Trounced Value
Past Decade: This decade the Russell 1000 Growth outperformed the Russell 1000 Value by ~3.4% on an annualized basis, or by more than 107% from a total return perspective.
Next Decade: The outperformance of growth or value tends to be cyclical. During a market boom, growth tends to outperform while following a market correction, value tends to outperform. A notable driver of growth this past decade has been low interest rates because growth stocks tend to outperform with a lower discount rate. As mentioned in our Q2 Quarterly, the historical magnitude and speed of recovery when growth outperforms value indicates that timing a snapback to value could be difficult. However, missing the return potential given the asymmetry of the growth/value equity distribution is suboptimal, and for this reason, we believe adding to value over time could be attractive.
Active vs. Passive Debate Expanded
Past Decade: Following the Great Financial Crisis, fund flows have been directed from active managers into passive index funds and ETFs.
Next Decade: . Availability and growth of passive investing alternatives has shifted pricing power from asset managers to asset owners and distribution platforms. We expect more industry consolidation, fee pressure and product innovation. Active managers will continue to look for ways to differentiate themselves, with ESG and alternatives serving as two potential areas of interest. Vehicle format is also something that could evolve over the next decade, with some of the first semi-transparent ETFs recently approved by the SEC.
ESG Investing Emerged
Past Decade: Per the Callan Institute’s 2019 ESG Survey, nearly 62% of investors who have incorporated Environmental, Social, and Governance (ESG) factors in their decision-making process have done so in the past 5 years. That same study shows that 42% of institutional investors are now considering ESG criteria in their decision making process.
Next Decade: Strong attention to ESG considerations should drive improved data collection, as managers seek evidence of ESG’s impact on risk-adjusted returns. However, ESG integration, the explicit and systematic consideration of material ESG information as part of the investment process, is still largely uncharted territory. Active managers have an opportunity to differentiate themselves in this space and potentially improve risk/return outcomes for clients. While ESG efforts to date have been primarily equity-driven, ESG investing has potential for expansion across asset classes, specifically in fixed income strategies.
China Became A Major Global Economic Player
Past Decade: In 2010, the U.S. economy was still more than twice the size of China’s economy. China has quickly closed this gap though, and is projected by 2024 to be within 20% of the U.S.' GDP and be more than three times larger than Japan’s economy.
Next Decade: Given China’s growth, trade tensions over the past year were a natural outcome as China and the U.S. battle for global economic leadership. The “us” vs. “them” mentality will likely intensify over the next decade as the two nations continue to compete for footing on the global stage. Though the U.S./China trade war at the end of the decade appears to be cooling off, any prolonged action by either government to attempt to gain an advantage could be detrimental to global growth. Should relations remain cold over the next decade, this could pose a risk to global markets.
Public vs. Private Market Growth Divergence
Past Decade: Private equity AUM growth over the past decade has outpaced public equity market cap growth. However, assets in public markets still dwarf the private market
Next Decade: With muted return expectations for public markets, the SEC’s easing of the accredited investor standard required to invest privately, and IPOs generally occurring later in a company’s life cycle, investor interest could continue to accelerate private market growth.
All data is as of 12/31/2019 unless otherwise noted. Opinions represent those of Glenmede Investment Management, LP (GIM) as of the date of this report and are for general informational purposes only. This document is intended for sophisticated, institutional investors only and is not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIM’s opinions may change at any time without notice to you.
This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. It may contain information which is not actionable or appropriate for every investor, and should only be used after consultation with professionals. References to risk controls do not imply that all risk is removed. All investments carry a certain degree of risk. Past performance of any strategy, index, area or security is not indicative of future performance. Index performance is provided as a proxy for various market segments; typically you cannot invest in an index. Individual investments may experience performance materially different from that of their relevant index, as a result of market forces and management fees. Information contained herein is gathered from third party sources, which GIM believes to be reliable, but is not guaranteed for accuracy or completeness.